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\title{Optimistic versus Pessimistic\\
—Optimal Judgmental Bias with Reference Point}
\author{A THESIS SUBMITTED \\
IN PARTIAL FULFILLMENT OF \\
THE REQUIREMENTS \\
FOR THE DEGREE OF\\
MPHIL IN ECONOMICS
\\
\\
SI CHEN \\
\\
Department of Economics\\
\\
St Antony's College\\
\\
University of Oxford\\
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\\
Supervisor: Professor Vincent Crawford
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\\
Word count: $\sim$11000
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\begin{abstract}

This paper explores the reference-dependent assessments of subjective beliefs. It presents a theoretical model where a loss averse agent optimally choose subjective expectation as reference point to balance the current felicity from optimistic anticipation and future stronger disappointment. In situations with intensive loss aversion and high chance of failure, the fear of loss make pessimism preferable to optimism. Consistent with empirical evidence, we conclude that confidence increases with the real chance of success. Application on information timing preference shows that optimistic agents has preference to early information. Furthermore, optimistic agents who fail to recognize their biases in decision making tend to be risk-addictive and thus invest aggressively in the portfolio choice example; instead, sophisticated agents act similarly to rational ones except weight higher on low ranking outcomes due to loss aversion. In the portfolio choice problem, sophisticated agents can take excess risks by being pessimistic because low expectation reduces their sensitivities to losses.

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